Delaware's Annual Franchise Tax: A Guide to Calculating and Paying for Businesses

Many startups are coached to form their corporation in the State of Delaware.  The reasons for doing so generally include Delaware’s well-respected and established corporate laws and its corporate law court system.  In addition, Delaware does not impose a state income tax on corporations organized but not doing business in the State of Delaware (although this does not excuse corporations based in other states from paying the state income tax when required by the startup’s home state, such as California.  These factors tend to favor large, publicly-held corporations – which many startups aspire to be someday.  For startups seeking venture capital or angel funding, may investors simply limit their portfolios to investments in Delaware corporations. 

Soon after the end of the Delaware startup’s first year, the startup receives a notification that the Delaware Annual Franchise Tax is due, and that notification often causes great stress, because the state of Delaware will tell you what that franchise tax amount is – and unless some planning and careful thought has been given to the corporate structure at the front end, the franchise tax amount can be unnecessarily large. 

In this article, we will explore the Delaware annual franchise tax on corporations and how they are calculated under various methods.

What is the Delaware Annual Franchise Tax?

The Delaware Annual Franchise Tax is a tax that is imposed on corporations that are organized in the State of Delaware. The tax is based on the assumption that corporations benefit from the state's laws, infrastructure, and business environment, and the tax is a way for the state to generate revenue from these businesses.  One way to look at it is the tax is the cost to pay for the privilege of being a Delaware corporation. The tax is imposed regardless of whether or not the corporation has conducted any business or generated profits.

The Delaware annual franchise tax is due on or before March 1st of each year, together with an Annual Report. Failure to file the Annual Report or pay the franchise tax can result in penalties, interest charges, and the loss of good standing with the state of Delaware.

Franchise Tax Calculation

The state of Delaware offers two ways to calculate the annual franchise tax for corporations, and it is important to understand how the use of each method affects the franchise tax required to be paid.  Each corporation is free to choose either method to pay the tax using the method that results in the lower franchise tax amount.  It’s important to remember that the Delaware notification always assumes the use of the Authorized Shares Method, explained below, because that method is the “default” method used by Delaware.  The state simply does not have the information required to calculate the tax using the other method.

Authorized Shares Method

The most common method of calculating franchise tax is the Authorized Shares Method. The Authorized Shares Method uses the total number of shares authorized by the certificate of incorporation and is calculated as follows:

• Up to 5,000 shares – $175 (the minimum annual franchise tax);
• 5,001-10,000 shares – $250; and
• each additional 10,000 shares is an additional $85 (with a maximum annual franchise tax of $200,000.

Assumed Par Value Capital Method

The Assumed Par Value Capital Method is an alternative method of calculating the annual franchise tax and, for many corporations, usually results in the lesser amount of tax.  To use this method, startups are required to report specific information in the Annual Report, including the numbers of issued and outstanding shares and total gross assets relating to the fiscal year ending the calendar year of the report.  The tax rate under this method is $400.00 per million or portion of a million of “assumed par value capital” – which is determined based on the assets and issued shares. The minimum franchise tax for corporations using the Assumed Par Value Capital Method is $400. 

The Delaware Annual Franchise Tax can be a significant expense for businesses, and the calculation of the tax can be complex. It can be a trap for the unwary.  The Delaware Secretary of State provides example franchise tax calculations at https://corp.delaware.gov/frtaxcalc/.  If you have questions about this topic or any other topics facing your business, consult with a trusted advisor for the most up-to-date information on how the franchise tax is calculated.